Optional or Obligation: An Explanation of Mortgage Insurance
There are many payments associated with buying a new home. Earnest money, a new mortgage payment, taxes, and home insurance are a few of the costs that homebuyers are typically aware of when they start the home buying process. However, there is another kind of insurance that is sometimes required and it is likely added right to your mortgage payment: mortgage insurance. While mortgage insurance is not required in all situations, you should know what it is, why it's needed, and how does it help me?
What Is Mortgage Insurance?
Generally speaking, lenders require borrowers to purchase private mortgage insurance (PMI) when they are paying less than 20% of the home's purchase price as a down-payment. Less than a 20% down payment adds risk for the lender and mortgage insurance protects the lender in case of default. If your down-payment is larger than 20%, mortgage insurance is not required. There are two basic kinds of mortgage insurance, single premiums with a one time up-front cost or monthly payments. Your loan officer will analyze your situation and guide you to the best type of MI for your transaction.
Benefits of Mortgage Insurance
There are benefits for homeowners to the private mortgage insurance obligation. If you are planning to buy a bigger home than you have the down-payment for, don't want to place all of your available cash on the table for the down-payment, or simply don't have a very large down-payment to offer, lenders can help you get the mortgage that you need now by requiring the PMI. Without the PMI, the loan may not be approved as the risks for the lender would be too high.
How Much Does Mortgage Insurance Cost?
In conventional home loan situations, private mortgage insurance rates are determined by the lender's private mortgage insurance provider. Several factors determine your rate. These include:
- Your credit history
- Type of property
- Amount of down-payment
- Type of loan
- Living in the home versus using it as rental property
When Can I Stop Paying for Mortgage Insurance?
With monthly mortgage insurance on a primary residence, PMI automatically drops at 78 LTV (Loan-To-Value) determined by dividing your principal loan balance by the original value. Follow the information on this MGIC resource. Borrowers can request cancellation of mortgage insurance based on original value or using current value. Very specific criteria apply to each type of request. Commonly, borrowers can request that private mortgage insurance be dropped when the loan-to-value ratio of the home reaches 80% and the borrowers have consistently made on-time payments. In order to reach this point faster, borrowers can make additional payments to the principal of the loan. Additionally, borrowers can request that PMI be cancelled in the event that the value of the home increases substantially, which also decreases the loan-to-value ratio. When requesting that PMI be cancelled at 80% LTV, most lenders will require appraisals and additional paperwork. The good news is that federal law requires private mortgage insurance to automatically be cancelled when the loan-to-value ratio of the home reaches 78%. Nevertheless, you should compare the costs of an appraisal with the cost of continuing to pay premiums to make sure you discontinue mortgage insurance when it's financially beneficial for you.
If you are just starting the home-buying process, private mortgage insurance can seem like a scary idea. In reality, private mortgage insurance can help you purchase your home sooner while protecting the lender and getting you a great mortgage. For more information about obtaining a home loan from a trusted lender, contact us or apply today.